Cashflow Is King – but Include Total Return

I don’t care how rich you are, it is impossible to overlook the importance of cashflow in your financial planning. There is a reason lottery winners and Premiership footballers sometimes go bankrupt. If you’re spending more than is coming in, you’re getting poorer; and as you prepare for retirement, you’re going to need to really get a grip on your cashflow.

As we build wealth throughout our working lives, cashflow is obviously important. Unless we spend less than we earn, we’ll never build anything, except by relying on others in the form of inheritances or whatever.

As we plan our retirement, we’ll no longer be earning in the true sense of the word, so this is going to need a change of mindset and how we think about the money that passes through our hands, as well as the wealth we have built.

Think Total Return Rather Than Just Income

As I say, when we’re earning an income from work, then income is an easy concept to understand. We work 9-5, we get paid at the end of the month – simple. If we have money in the bank and it pays interest, that’s income. If we have a rental property or two, then they produce an income too.

In retirement, there is likely still to be some part of our cashflow that is income – DB pensions, the state pensions, maybe continuing rental income, but to a greater or lesser extent, we’re going to be supplementing that income with withdrawals from capital.

In my experience as a financial planner working with clients at this time in their lives, this takes something of a mental leap for many people to get their head around. After all, they’ve been building wealth furiously for so long, the thought of actually making withdrawals from their portfolio is anathema to them.

Of course, if your cashflow needs could be met entirely by the ‘natural income’ from your portfolio, then that would be great – you’d have no need to dip into the portfolio ever. But for most of us, this is an unlikely eventuality.

Later in the blog series, we’ll look in detail how to position your portfolio for longevity. After all, if we are going to dip into our money, then we need to make sure that it never runs out, if we can help it. But for now, I think we just need to understand the interplay between these three things:

• Natural Income – income ‘thrown off’ by your investments. Interest from cash and bonds, dividends from equities, rent from property. Natural income is distinct from the value of the underlying assets that produce it
• Total return – the combination of income and capital growth. Often natural income is reinvested to buy more of the capital-appreciating asset. When you see factsheets for an investment fund, you’ll see the natural income expressed as a percentage yield, but the performance figures include that in their annual returns along with the growth of the underlying assets
• Withdrawals – either ad hoc or regular withdrawals of capital over time. This requires selling down assets and so needs to be timed carefully where possible. The chances are you’re going to need to make withdrawals from capital as you enter retirement, and that will, by definition erode your capital

Missed the last blog? Or ready to move on to the next post?